Banks are strengthening their
foreign exchange options desks, investing in people and
technology, as companies and hedge funds seek protection or
profit from big moves in major currencies.

Banks are strengthening their
foreign exchange options desks, investing in people and
technology, as companies and hedge funds seek protection or
profit from big moves in major currencies.

Options volumes surged in early 2013, mirroring a pick-up in
the spot market and reflecting strong trends in
major currencies, which analysts expect to continue.

These trends, particularly in the yen and sterling, increase
money-making opportunities for hedge funds and are an incentive
for corporate investors to protect their exposure.

Barclays said they saw a 40 percent rise in options volumes
in January compared with a year earlier, and banks in general
were looking at foreign exchange as an area to expand.

FX options give holders the right to buy or sell currencies
at an agreed price and time, reducing the risk if prices swing
wildly, and are mostly traded over the telephone or via instant
message on computer screens.

"We are optimistic on the coming year. We have seen stress
in a global economy that is operating at different speeds, which
offers potential for greater currency management. It makes sense
to use options to take or reduce risk," said James Bindler, head
of global FX options at Citi.

"It's the hedge funds that have really picked up activity."

As the market revives, demand has risen for so-called exotic
options with more complex features. That follows a sharp
drop-off after the 2008 financial crisis when many companies
booked heavy losses on exotic bets that turned sour.

The bigger banks, including Morgan Stanley, are channelling
more resources into electronic options trading in anticipation
of looming regulations that are likely to push the market
towards increasing automation.

But the sheer complexity of some exotic structures means
machines will struggle to take over entirely, with many options
still needing to be priced manually by humans.

Among banks boosting their firepower, Nomura has hired three
new traders since mid-2012. Global head of foreign exchange, Jai
Rajpal, said there would be further investment this year.

While agile hedge funds seek to profit from bets on
currencies rising or falling, banks also report an increase in
hedging by companies seeking protection from sharp price swings.

Many were caught off-guard by the dollar's 20 percent rise
versus the yen since November and the British pound's 7
percent slide against the U.S currency this year.

"What we have seen more and more over the last two years is
some corporates having a very good result in terms of their core
business, but ending up with a loss because of the weaker
currency in which they trade," said Remo Fritschi, head of FX
bank sales for EMEA and North America at Morgan Stanley.

ELECTRONIC FUTURE

Regulatory changes under the Dodd-Frank financial reforms
passed by the U.S. government, look set to push more of the
opaque derivatives market on to transparent trading and clearing
platforms in the next couple of years.

"You have to ask a number of banks and be able to show you
traded on the best price. You have to be electronic in that
world," said Giles Jewitt, head of FX options automated trading
at HSBC. His role was created two years ago as the bank stepped
up its efforts to automate options.

Straightforward "vanilla" options lend themselves to
electronic trading, but exotics can include unique terms and
conditions that make them hard to commoditise.

The more complex an option, the fewer people post prices and
the thinner the liquidity, making it less suitable for
electronic trading.

This and the prohibitive costs mean even an expanded FX
options market is likely to be dominated by the deep-pocketed
big banks, just like the spot market.

Market players estimate only 10 to 15 of the bigger banks
trade options electronically and smaller players may struggle to
bridge that gap.

"It's going to be hard for second-tier banks to make that
investment. In terms of expense, it took us the better part of
three years to deliver a system that can deliver tight and
accurate prices," said Citi's Bindler.

The main advantage of electronic trading, whether streaming
live prices to clients or using algorithms to generate smaller
quotes automatically, is that it enables traders to concentrate
on larger flows and the banks to handle higher volumes.

But Nomura said corporate clients will always need bespoke
exotic structures tailored to fit their individual businesses
and that can only be handled by a person.

Even banks that are already established in electronic
trading recognise its limitations.

"A corporate who has $6 billion of hedging exposure will
always want to do it through voice," said one head of options
trading.